One thing you can’t avoid when running a business is the need to spend money to make money. Staff, premises, supplies and more – there are plenty of outgoings to be weighed up with your incomings. It’s great news when more is coming in than going out. It means you’re turning in a profit. For any successful business, that’s the name of the game. And one way to track just how profitable you are is to calculate your gross margin.

Now, there are so many things that can take up your attention when running a business. The money situation is just one of them. And we know there are plenty of terms that could sound confusing if you don’t know what they are. After all, what does gross margin even mean? The answer to that question – and why it’s important – can be found in this helpful guide. With it, you’ll hopefully get a better idea of how to power your business up to even greater heights.

What is gross margin?

To put it simply, the definition of gross margin for a business is the total value of sales minus the cost of the goods sold (COGS). This specific metric aims to show how well run the business is. In essence, it’s the overall profit you’re making on your products or services once you deduct whatever is spent on things like production or supplies.

As a term, “gross margin” can also be called your gross profit margin. The figure is expressed as a ratio or percentage. So, what does it mean if a business has a gross margin of 35%? It means that for each pound earned through the sale of products or services, your business has kept 35p – with the remaining 65p being spent on fulfilling that order.

The difference between gross margin and net margin

In accounting, you might hear the term “gross” used in comparison to “net”. It’s an important distinction to make too. As described above, your “gross margin” is the amount left over once the cost of your products or services is deducted from supplying them. Such costs will include things like supplies, raw materials and anything else directly related to that order.

In contrast, net margin is the overall profit generated from your revenue. It factors in all your business expenses – not just COGS. So, that’s items like rent, staffing costs, utility bills, debt repayments and anything else you find yourself having to finance. Like gross profit margin, it will be expressed as a percentage and is quite useful as an overall business barometer.

How to calculate gross profit margin

It’s not difficult to learn how to work out your gross profit margin. The formula is a straightforward one – and can be a real eye-opener when it comes to your finances. Here it is:

(Order value – COGS) / order value x 100 = Gross Profit Margin

OK, so that looks simple in theory. But how about in practice? Well, let’s take an example and give you a clearer idea of how it all works. As a smaller clothing business, you sold a t-shirt to your customer for £20. The cost of materials and production for one t-shirt comes out at around £12. So, let’s put that through the gross margin formula:

  • £20 – £12 = £8
  • £8 / £20 = 0.4
  • 4 x 100 = 40%

Here, you can see your gross profit margin on the sale of one t-shirt is 40%, with a gross profit of £8. It’s a small example – but one showing you how to work out gross margin all the same.

We know that as a business leader, you might not have time to calculate your gross margin and now you don’t need to. Once you sign up to Pulse, we will tell you what your gross margin is every single month – and it’s totally free!

Why is it important to know your gross margin?

Knowing your gross profit margin is important for two main reasons. The first is a big one as it helps you to see just how profitable your business is. In fact, it’s not only how profitable you’re looking – but how effective your pricing and purchasing strategies are. And with that detail, you can monitor your progress against targets and growth ambitions.

Second, you’ll see which products/services are doing the heavy financial lifting for your business on a line-by-line basis. From that, you can take decisions based on which options aren’t earning you enough and focus on those that are. You can even make broader decisions such as changes in suppliers, materials or resource.

For some businesses, gross profit margin can be a useful benchmarking tool too. If you observe what competitors are achieving in your sector, you can see how your business compares.

What does a good gross margin look like?

The higher the percentage, the better the gross profit margin. That’s what your business will be aiming to achieve. If not now, then it certainly can be a longer-term target as you seek to grow your business when you’re a smaller operator. By reaching a higher gross profit margin on your products or services, it should ultimately equate to more money in your coffers.

So, does this mean you need to be coming out and aiming for a gross margin in the 80s or 90s? No. Based on one academic research piece, a “good” margin will vary from sector to sector. For example, apparel and clothing firms average out with a gross margin of 53%. Food wholesalers, however, will record a much lower margin.

It’s worth remembering that smaller and newer businesses can face significant competition just to get noticed. As such, don’t be worried if your gross margin is on the low side to start with.

How can you improve your gross margin

The first thing to remember is that you shouldn’t walk before you run. Taking the right steps at the right time will help grow your business. At the same time, you’ll have chances to boost that gross profit margin. In the short term, however, some of the things you can do include price changes, supplier deals and lower running costs.

If your gross margins can point towards inefficiencies in your supply chain, look to streamline as much as possible. And don’t rely on discounts and low prices to compete. Focus on experience.

One other way that you can improve your gross margin is to use Pulse – our free business tool that makes all the difference! It aims to put you in full control of your financial health. The data and analysis it gives you will enhance your decision-making as a business owner. Real-time analysis of the gross margin data you hold, for example, means you can fix any issues that are squeezing your profits.

Explore how Pulse can help you and your business today. Get a full, clear picture of all aspects of your business’ finances. Get in touch with us and let us take your business to the next level with game-changing insights.